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Egypt Needs Free Trade, Not More Aid

Egypt is racing toward dictatorship. Gen. Abdel Fatah al-Sisi even arrested opponents of the proposed constitution in the January referendum. However, Washington always has been more interested in maintaining influence than encouraging democracy or promoting development in Egypt. Toward that end the U.S. provided more than $75 billion in “aid” over the years. In fact, the cash bought little leverage. Hosni Mubarak spent decades oppressing Egyptian citizens and persecuting Coptic Christians despite Washington’s advice to the contrary. Israel’s military superiority, not America’s money, bought peace. Cash for fancy weapons may have won privileged access to Egyptian airspace and the Suez Canal, but today the Egyptian military needs the U.S.—for maintenance on and spare parts for those same weapons—more than the U.S. needs the Egyptian military.

“Washington should set aside political differences and propose that the two governments free up investment and trade.”

Unfortunately, as elsewhere in the Third World, foreign “assistance” actually hindered economic development, effectively subsidizing Cairo’s inefficient dirigiste policies. Most undeveloped rural states attempted state-led development strategies to modernize, with disastrous results. Yet access to foreign cash reduced pressure to make politically painful economic reforms. So it was in Egypt. As long as enough money was available to pay off important interest groups, most notably the military, even a dictator like Mubarak saw no reason to risk political unrest.

A decade ago the government finally recognized the need to open the economy. Rebecca Nelson and Jeremy Sharp of the Congressional Research Service reported on “wide-ranging structural reforms, including tariff reductions, privatization of state-owned enterprises, and reductions in regulation of the private sector, among other policy measures, that aimed to improve the business environment and make Egypt’s economy more competitive.” Meredith Broadbent of the Center for Strategic and International Studies cited corporate tax reductions and insurance regulation modernization. The result was international recognition for Cairo’s efforts, increased foreign investment, and increased economic growth.

However, Egypt then began to fall behind other reformers. According to the Economic Freedom of the World index, Egypt ranked 53 of 123 in 2000, fell to 94 of 127 in 2003, rose to 78 of 141 in 2007, and then fell back to 99 of 144 in 2010. Important problems remained. For instance, Broadbent pointed to the survival of “significant elements of a heavy-handed statist bureaucracy.” The banking system was opaque, monopolistic and inaccessible. A joint report by the Carnegie Endowment and Legatum Institute pointed to the need to give poor Egyptians clear title to their property, reform the bankruptcy law, and reduce costs of opening, operating and closing businesses.

Corruption was pervasive: Transparency International ranked Egypt at 114 out of 171 countries in 2013. Writing for the Carnegie Middle East Center last June, Ibrahim Saif and Ahmed Ghoneim cited as problem areas “allocations of land, freezing of anti-trust laws, and dubious privatization deals.” They set forth a reform program based on more reliable policies and regulations, minimal intervention in the credit markets, greater transparency in public finance and military economic activities, and reform of investment policy, along with political and judicial improvements.

The economy remained dominated by cronyism and privilege. The military controls anywhere between 15 percent and 40 percent of the economy. Other influential individuals and interests also benefit from state favors. Saif and Ghoneim observed that larger private firms “have disproportionate access to decision makers and may be skewing policy in their direction.” In fact, members of the business elite are suspected of having helped orchestrate artificial shortages to intensify public dissatisfaction with President Mohammed Morsi in order to help justify a coup.

The most serious economic hindrance was extensive and expensive consumer subsidies, particularly for food and fuel. Most of the benefits did not go to those in most need. Alas, explained my Cato Institute colleague Dalibor Rohac: “Not only are subsidies highly ineffective in helping the poor, they are also an increasingly unsustainable drain on the country’s public finances and its foreign reserves.” The cost accounts for roughly a third of the government’s budget and 14 percent of GDP.

Thus, even after the Mubarak reforms unemployment and inflation remained high while Cairo ran large deficits. The benefits of reform failed to reach many people, especially the extreme poor. The situation worsened after the 2011 revolution.

The Morsi government cut gasoline subsidies and raised taxes, only to reverse course under public fire. Cairo also hiked government employment and salaries. The public deficit increased to 11 percent of GDP. Worse was the business environment. Observed Nelson and Sharp: “Continued insecurity stemming from deterioration in law and order has hampered investment.” Other analysts pointed to the lack of certainty of even the direction of policy.

The coup was another large step backwards. The government is focused on suppressing the Brotherhood and any other opposition, as well as reconstituting the “deep state” and old political and economic relationships. Indeed, Gen. al-Sisi appears to be determined on a return to “normal.” Reported the Washington Post: “now some businessmen and officials implicated in post-uprising corruption probes are again in positions of power and influence, including in the cabinet appointed last summer by the military.”

Nor is Gen. al-Sisi likely to court unpopularity by adopting tough reforms. The prime minister said the government plans to “rationalize” the subsidy, but economic reform appears to be a low priority. Finance Minister Ahmed Galal said he hopes to find more outside money to spend on “public investment” and “to bring about greater equality.” In September the regime launched a “$4.2 billion program for “economic development and social justice,” but big spending initiatives elsewhere have not ended well. The government also intends to introduce a public sector minimum wage this year, which will hike state costs and, businesses worry, might eventually be extended to the private sector.

Military rule could offer a form of stability. However, Gen. al-Sisi’s brutality, including the slaughter of Brotherhood protesters in Cairo in August, has encouraged increasingly violent opposition. Policemen are regularly being killed, and both auto and suicide bombings are on the rise. During the 1990s when the Brotherhood was similarly banned some members conducted a campaign of low-level terrorism.

Even sporadic violence, especially if targeting foreigners, could frighten off investors and tourists. Although a number of American firms say they are staying, greater uncertainty in Egypt is one reason Apache Corp. of Houston, the largest U.S. investor in Egypt, sold off a third of its oil stake to China’s Sinopec. Chevron has divested its gas station network.

In this environment American financial assistance would be even more harmful than before.

The massive aid coming from Saudi Arabia and other Gulf states—given purely for the political purpose of combating the Muslim Brotherhood—reduces any financial pressure on the regime to streamline economic policy. Unfortunately, reported the Financial Times: “Another concern, voiced by business and economists, is that the recent easing of Egypt’s economic predicament thanks to largesse from oil-rich Gulf countries, may result in an indefinite deferral of painful but much-needed structural reforms.” More checks from Washington would make the government even less likely to enact those reforms.

While more government-to-government aid to Gen. al-Sisi’s burgeoning pharaonic state would be counterproductive, freer trade would be a positive good. Encouraging greater commerce among nations would naturally increase the demand for Egyptian products and services. Instead of offering artificial subsidies, lower trade barriers would improve the natural reward for an entrepreneurial population.

Two years ago Meredith Broadbent proposed negotiating a free-trade agreement—previous talks left off in 2005—and updating the bilateral investment treaty, probably the easier and quicker task. The Carnegie-Legatum study suggested as a second best creating “qualifying Industrial Zones—especially in the underdeveloped areas of Upper Egypt.” The point is not to boost whoever happens to be ruling the country at the time. Rather, an FTA would aid entrepreneurs and their workers, who would be the ones taking advantage of increased access to the American market. Nine years ago the Institute for International Economics projected that an FTA would increase Egypt’s GDP by three percent annually.

Broadbent pointed out that a new accord also would benefit U.S. firms, which have been left at a disadvantage by the EU-Egyptian FTA. Today America’s top exports to Egypt are agriculture, electronics and machinery, metals, and chemicals. FTAs, she argued, “can serve as systemic tools to help pry open closed government regulatory processes.”

Egypt’s problems are many, serious, and deep. Absent an inclusive political process, the country likely faces an unstable and violent future. However, even wise political leadership, so far lacking in Gen. al-Sisi’s course, is not enough.

Economic reform also is necessary. That is unlikely to come from lectures and money from foreign governments. But the prospect of increased participation in international commerce would offer a far more powerful and direct incentive for action. Washington should set aside political differences and propose that the two governments free up investment and trade.

Doug Bandow is a Senior Fellow at the Cato Institute and a former Special Assistant to President Ronald Reagan. He is co-editor of Perpetuating Poverty: The World Bank, the IMF, and the Developing World.